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    Only an equation?

    Fatih Özatay, PhD20 May 2010 - Okunma Sayısı: 818

     

    I believe that the recent developments in the European Union should have thought us that fiscal rule is not only an equation. In the Eurozone member states cannot exceed a certain threshold of public debt and budget deficit in proportion to their GDP. However the mentioned thresholds have already been exceeded and the only cause of this is not the global crisis for some countries. As in the case of the Greece example, the threshold had been exceeded even before the global crisis. What is more, this was enabled by manipulating budget figures.

    On the other hand there exists another phenomenon:  The two rules of the EU mentioned above are not 'cool' enough in form of equations. Let us focus on one of the rules to address this. The rule says that the debt ratio shall not exceed 60%. To denote this rule you only need one letter (let's say d), one mathematical term (say <) and the number 60. The equation is not cool also because it is static. In the sense that it does not tell you what to do if the debt ratio exceeds 60%, for instance.

    However, you can write many symbols and figures to derive more dynamic equations. The fiscal rule that came to the agenda once again is based on such an equation: if the central government budget deficit in the previous period exceeded 1%, the budget in the present period will be tightened to offset the excess deficit in the previous period. Or, if the growth rate was over 5% in the previous period, the budget will be tightened slightly to save for the rainy days.

    Cool. But, it is not reasonable to expect that fiscal rule practices in which only the equations are highlighted will prove successful. This was the case also in the past, but it has been clarified further. The recent developments in the EU revealed that a poorly monitored and poorly supervised fiscal rule the violation of which is not sanctioned cannot be reliable.

    Since we do not introduce a fiscal rule just to keep up with the trend, we must have a certain objective. What do we aim? We can stress two main objectives. First, we want to eliminate the uncertainty about the future course of the fiscal policy. This one alone is a critical objective. Understanding how the economic policies will be shaped in the future makes it easier to make future decisions, or investment decisions for instance. Second, we want to assure everyone that the budget deficit and the public debt as a derivate will not go beyond a certain threshold. Both the 2001 crisis and the current crisis in Greece have proved how important it is to achieve this objective.

    So in this context let us examine how a successful fiscal rule practice must be. Since we seek to reduce uncertainties, we have to make sure that the successive governments will also abide by the rules. How can we assure this? Obviously by negotiating and settling with the opposition parties before the introduction of the rule. We must also hear the opinions of civil society institutions. Is the rule at hand approved by the opposition parties? Assume that it is. Then, what happens if we violate the rule? In other words, what will the sanctions be if the measures stipulated by the dynamic equation mentioned above are not met? Is a rule that does not impose any sanctions actually a rule?

    Now let us focus on the second objective: to give assurance. To this end, the public must be able to monitor on a monthly basis how the central government budget deficit evolved. We immediately have to learn about any changes in figures and plus trust in the figures. This must be enabled by a competent and independent authority.

    Assume that we started to use the fiscal rule as of the end of the year. The equation defines the level of budget deficit in 2011. But as of the end of the year we will most probably know the budget deficit figures only for the first nine or ten months of 2010. I can still estimate it roughly. However, the equation involves another important variable: the growth rate in 2011. This figure will be estimated and this estimation will affect the budget of the coming year. The public must therefore be informed about the reliability of this estimate. For instance, at the end of 2008 it was estimated that the economy will grow by 4 percent in 2009 and the 2009 budget was formed accordingly. In the end, the economy contracted by 4.7 percent. Would not it be nice if the solidness of this estimate was reviewed by an independent and competent authority?

    Anyway, that is enough for today. Let me end my words with the title of a report by Ümit Özlale: "Only if the Fiscal Rule was nothing but an Equation"

     

    This commentary was published in Radikal daily on 20.05.2010

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